I'll start by just outlining what we're going to try and cover today, and then we'll get stuck in.
So we're looking at we're looking at early stage entrepreneurial businesses.
I'm not I'm not trying to deal with the established multinationals.
I'm talking about the sort of businesses that you may might set up to exploit some technology or a market opportunity or something like that.
What are we going to look at? Things like the structure, how you set the business up, and there's some important stuff to learn to learn there,
how to fund it, how to make sure that you've got the right funding by setting good budgets, record keeping.
You may spot a pattern emerging when when the subject of recordkeeping comes up.
I may just bang on about how important good recordkeeping is.
Just might. Well, we'll see how that that develops. Compliance.
There is a lot of there are a lot of rules out there. Generally speaking, they're not too onerous.
As long as you do things the way that the rules want you to do them, it isn't it isn't too bad a world.
There are there are some jurisdictions where they the compliance rules are very onerous.
There are others where they're incredibly lenient. But you perhaps wish there were a bit more onus.
But here here in the UK we have a fairly balanced,
relatively lenient compliance regime for ordinary businesses reporting businesses
perform and financially that means reporting in the various directions.
And we'll talk a little bit about what needs to be done, what can be done and how best to achieve it.
And tax will rear its ugly head and just just occasionally friendly head as well, but mostly ugly.
And we'll talk a bit about how to keep HCM robbers and cheats off your back.
Okay. So we're talking about, generally speaking, to two types of business.
When they're set up, there's the ones that will hit the ground running and start making widgets or providing services on day one.
And then there's the ones that are going to be perhaps in existence for, you know, some months, couple of years or in the case of,
you know, drug discovery companies, 20 years before they'll actually make anything that anybody will be able to to to sell.
And the reason for that, there's a lot of similarities between the businesses,
but there's quite a few differences, particularly in the area of funding.
And we'll talk a little bit about that later on.
Just out of interest, the business, the business you're involved in or thinking of setting up or whatever,
how many people would regard that as one of the hit the ground running type businesses that we'll start you.
Just give me a show of hands of people are thinking of setting up a business that will be doing stuff from day to day one.
And how many are in the sort of well, I've got a bit of technology that needs finishing off or designing or stuff like that.
Okay. So it's nice mixture, probably a little bit more of the second sort, but nonetheless is a nice mixture.
So we'll we'll cover both bits. Okay.
This is vehicles. I'm not talking about the company car here.
I'm talking about the the the the constitutional structure that is used to set the business up.
The standard thing for most businesses in the UK is a simple, limited company.
And the reason for that is because for most cases, it is the most appropriate business.
The there's the unincorporated business. So that's the sole trader, me trading.
As you know, the business is mine and I own everything and so on.
Or the partnership, the traditional partnership,
where there's two or more people who are carrying on business in common with a view to profit as defined by the Partnership Act of 1890.
That wonderful piece of legislation that's 104 over 25 years old now has stood
the test of time and is still great for defining how how partnerships operate.
Anyway,
we look at so that unincorporated business sometimes the right choice sole traders partnerships when the business is small or low risk or very simple.
The reason for mentioning low risk is the clearly the title limited company.
Your liability is limited with the unincorporated businesses.
Your liability is not limited. All the partners or the proprietors are all jointly and severally liable for all the obligations of that.
So if there's any risk attached to it, probably best to avoid sole traders and partnerships.
The the the sort of thing that falls between the two is the LLP relatively,
relatively relative newcomer on the block, although they've been around for so decades now.
But they are a company legally and a partnership from a tax point of view.
And and they they, they're very useful in certain situations, although the rules have just very recently changed.
And the number of situations in which they are really useful aren't quite as many as they used to be.
But nonetheless, they're right that the commonest place you see is in partnerships of professionals,
architects, accountants, solicitors, that kind of thing, where it's probably the right, the right thing.
But for most companies that are going to bash widgets, provide consultancy, design,
software and so on, the right thing to do is just set up a limited company.
There are specialist entities for community based projects and things like that.
But beyond beyond the scope of this, today's session.
Okay. One of the most important things when you're setting up a company is to get the shareholding structure right on day one.
Okay. It's absolutely vital to do that because there's an awful lot it's very,
very difficult to change later and has the guy with his hands tied because he got the shares wrong.
And I will give you some detail about that, that if you come away with nothing other than that,
it will be a very useful thing to have to have picked up because it can be an absolute disaster to have the wrong shareholding structure.
Once the company gets up and running, okay, I'll give you a run, a run through as to an example of why it might be a mess.
A new research company has formed. It's going to invent something.
It's going to wear it's got a piece of software that's going to exploit or something like that.
And you know, it's based in Oxford. So there's lots of business angels around and a suitable choir of angels is found here,
are going to put some money in and they're going to pump in £1,000,000 for 25% of the company now.
Not not an unreasonable scenario, but very nice. And then one of the academics who founded the company gets to gets to take some shares.
And let's say he gets 10% of the shares, but he's not putting any money in.
So he's only going to pay face value, a pound a share for these ten shares.
So he's going to cough up a tenner from his back pocket for that.
Seems alright, isn't it. Okay.
An academic joins the board. He's going to be the technical director of this company.
That's why they they wanted him and why they offered him shares. Well, let's just go through what H.M. Revenue and cheating would say about that.
25% for a million quid. So a quarter the company's worth a million quid.
When I was at school, that meant that the company would have been worth 4 million quid.
Not to difficult maths there.
The academic has received 10% of that for a negligible sum, i.e. he's received shares worth 400,000 without having paid really anything for them.
So [INAUDIBLE] get a tax bill of 45% of 400,000 quid, i.e. £180,000.
And the company may actually be asked to pay 13.8% of 400,000 as well in National Insurance.
And the academic hasn't actually received any money at this stage at all.
Not a penny. And yet he's been asked by the tax man.
280,000. That's because she got the shares in the wrong order.
If you issue the shares to the academic on day one and then wait a decent interval and then take the investors money.
It works.
You can see what I mean about getting it right, getting it doing things in the right order and the danger of of getting it in the wrong order.
Okay. Once you've got value built up in a company.
And typically there are two things that cause that.
Well, three things come up with the cause that if the same IP transferred into the company or it builds up and acquires some IP,
protects it with patents or something like that, or creates it, that builds up value in the company if it makes profits.
Value builds up in a company.
And if he gets a funding round, if someone pumps in a million quid for a quarter of the company, then the company is worth 4 million quid.
And that that's a stake in the ground that the tax man will stick to and say, you know,
I need I need very, very and certainly need convincing that it's come down from that.
And therefore, you start moving these shares around.
You end up with problems. Any transfer of those shares gives two problems.
The transfer all has made a disposal which triggers capital gains tax, even if it doesn't get any money.
And the transferee could have an income tax problem.
If they're going to be involved in the company in any way as an employee or a director,
he needs to get these things right when there's no value in the company.
Stop, stop these sort of things happening. Okay.
Let's move on to budgeting. Okay.
Of those people who stuck their hands up. They've got businesses. The rest of it.
How many of them wrote a business plan? Can we have a show of hands? Business plan?
Yeah. I'd expect to see more hands than that. You should.
You should do it. Even if you. Even if it's only on the back of a [INAUDIBLE] packet.
You should do some kind of a business plan to.
To budget for your business. And in those, there'll be financial projections, which is a broad brush medium term.
Typically, the investors, if you're trying to get money out of investors,
you're going to go for five years, sometimes slightly longer, sometimes slightly shorter.
But that's the sort of thing. Very broad brush you'll be showing the the main figures, turnover, profitability, cash requirement and so on.
But once you get going, you need a much more detailed operating budget,
which is short term, perhaps only six months or a year, to measure performance against,
to make sure that having planned to do this and spend this and earn this and so on and so forth that you're actually doing it.
And if you're not doing it, get a a sort of explanation as to where you're departing from that.
So you're comparing performance when you're underway? Obviously, they've got to be consistent.
It's no good doing a business plan that tells the investors that you're going to make £10 million in the
first year of profit and then set your operating budget to make a loss or break even or something like that.
So you start with the same set of assumptions, same set of data, same underlying arithmetic.
Present them in a slightly different form. Talk about funding now.
We talk about the pre-revenue enterprises, the ones they've got some research to do or some development or some market research or whatever.
Finish the sell. Finish writing the software. Finish. Take the prototype from prototype two to production version, those sort of things.
You need equity. You can't get a bank to fund those.
And it's no good whingeing about the dreadful fat cats in the bank who are failing to support SMEs.
It would be inappropriate for them to do so that it wouldn't. It's not the right function of the banks to take a risk on a pre-revenue enterprise.
You need equity and the sources of equity are on the smallest scale.
What I often jokingly referred to as the three F's fools, friends and family who pump a bit of money in a second stage.
Then the flying in from from that cloud, the business angels, who tend to be people who've made, you know,
made their own modest pile from their own entrepreneurial activities and would like to invest in, you know, the next generation of of entrepreneurs.
Or if you move up to next scale, the venture capitalists, the the institutional, you know, add a couple more noughts.
There's no point going to them. And unless you want something with an awful lot of noughts on the end of it.
Those are the scales. But it's got to be equity because the banks will not, you know, grant you an overdraft to do to do R&D.
It just it just ain't going to happen.
On the other hand, revenue generating enterprises, first of all, they might not need any funding because if you are starting up,
say, providing services and the the first deliverers of those services are the founders of the business.
So they can do it without that being a cost to the business.
You know, that they're living on savings, you know, until they get the business up and going so they can provide the service,
get the got some revenue in and the business doesn't actually need any funding.
Or if it does, it could use debt or equity, both of which both of which work.
But if you've got a source of revenue and demonstrable source of revenue, then the banks might actually look at you and let you some money.
But. If you've been running a business which is basically using your own money or nobody's money,
you can pretty much do what you like as long as you're legal. The moment you've got somebody else lending you money, unsurprisingly,
they like to have things that allow them to see for sure that you're doing the right things with their money and
behaving in a way that is consistent with what they what you said you would do and is proper and successful.
So these additional responsibilities we'll talk about a bit in a moment.
But they do they do kick in if you've taken external money.
Right. We have got some money. We've got our business idea.
We've set the company up. What do we have to do? Well, the first thing is we have to register three times with H.M. Revenue and cheating.
Okay.
Firstly, for assuming we're a company, a corporation tax, if it's an LLP or a sole trader partnership or whatever, then it would be for income tax.
But there's a registration of the trading activity of the business, usually for corporation tax.
VAT. Because unless you are, your turnover is going to be below 79,000 or you're going to be doing only exempt supplies.
You're going to need to be registered for VAT. So that's a second registration and for PAYE and RTI.
Now as you can see, we're starting to get a few acronyms kicking in.
RTI, RTI, only one real time information.
Now, traditionally, the pay system during the year, your employer, if you're if you're if you are an employee,
their employer calculates your salary, calculates the tax, and then that's deducted and operates that through throughout the whole year.
And then we're pushing to return at the end of the year to tell H.M. Revenue and Customs what had been paid,
what had been deducted from it, and so on and so forth. They decided they need a bit more information about us.
And now. Every single time you get a payslip, an RTI submission has taken place.
HMRC knew what your gross pay was, what your tax was, what?
And I was before you did. Certainly before you got it.
Anyway, that is live information. So now they are on top of it.
And everybody who has employees and employees includes directors and pays them has to be registered for PAYE and RTI.
As I say, no employees because the directors inevitably get on the payroll.
If you're paying yourself or your fellow directors out of the company, they need to go through the P.A. system.
So we're going to keep some records. That's the closest you're going to get to a joke from me.
Sorry about that. I'm an accountant.
Not another not a humorist. What we're talking about here is bookkeeping, which isn't the same thing as accountancy.
And I'll come to what the difference is between the two.
They're both dealing debits and credits, but it's a bit like the difference between, you know, Lewis Hamilton and a taxi driver.
They're both drivers, but there's a bit of a difference between what they actually get up to.
Okay. Bookkeeping is a form of data capture,
ensuring that you get all the transactions that go through a business and stick them into the accounting records.
It's one of those things that needs a real, real painstaking accuracy.
It doesn't need great brilliance, but it needs these to be it's a sort of a job for the for the the detail person, not the not the big thinker.
Okay. What you can do. What you should do is implement systems of checks and controls.
It is possible because lots of people, much cleverer than me have worked on this.
It is possible to set up things where you can go right.
If you've recorded this correctly in the system and everything has been done properly and and completely, that number will agree with that number.
And if it doesn't, you must have done something wrong somewhere.
So go back and check and do it again.
But it does mean, you know, these checks and controls do mean it's possible to get things right and be absolutely certain that they are right.
And it is very important. Now, I said I was going to bang on about the accuracy of of record keeping.
And I am because there's no substitute for it.
It is not an exercise which allows for any creativity.
I mean, let's face it, accountancy is the one profession where the epithet creative is an insult, you know,
and quite rightly, these things have to be a complete and accurate reflection of all the things that have happened,
because without that, you're building blocks to do any kind of reporting and and planning aren't complete and the whole edifice collapses.
So it is quite important to do that and I will possibly mention that again before I finish.
But they are the basis for compliance. All the things that you are obliged to do.
Of a financial and tax nature need good accounting records reporting telling people that need to know like your investors like you,
like the tax man like the public companies house need to know what's going on.
And if you can't got the basic building blocks, you can't report that to them.
You get it wrong. And you know, that can result in mistrust or a prison sentence and everything in between.
Okay. Planning. You can't tell what you can and can't plan.
What you going to do next? Yeah. Unless you know accurately what you did this year.
So and also businesses change and the techniques and systems and so on that you need to to do that evolve over the life of an enterprise.
So you need to keep an eye on them.
So what all these financial records, the books, the books, the books, I don't think I, I don't think many businesses have them still in books.
But I'm old enough to remember when most businesses did have them in books.
Now they have them in computers they use for compliance.
They used for reporting. I saw this before. Planning, monitoring and so on.
Management reporting. So when a business is very tiny, the back of a packet is enough.
The people who set the business up and run it know every transaction.
And it's ever so easy to to to know where it doesn't.
It. The business doesn't have to grow to a particularly big size before you can't do that anymore, particularly if you're dead busy,
which you will be if the business is growing and you'll be dead busy doing
the science or the delivery or the marketing or whatever is you brilliant at,
you know, brilliant as being an accountant. Otherwise you'd be up here giving the talk and I wouldn't have to.
So you need to to give the usually give it the attention and put the systems in place and delegate the job to people who know what they're doing here.
And it's used for management reporting, as I say, is used for financial reporting.
That's the the formal bit at the year end that every business has to do and management have got to be involved in this.
I'm going to take a moment away from the slides here. Just recently I come to inclusion.
One of the biggest, biggest, biggest problems that I have encountered amongst people wanting to be entrepreneurs is the inability
that many people have to go from the culture of large corporate business to the culture of an assembly,
to the culture of a small business. I have seen that in a big organisation.
There will be a department that deals with toenail clippings with hundreds of people who are experts on toenail clippings.
So you don't have to worry about toenail clippings if, you know, if you are a senior manager.
In an Smee. There isn't a toenail. There isn't even a person who deals with that.
So if there are toenail clippings everywhere, the management, the business owners have to sort them out.
And the same is true of the detail of financial reporting and recording.
It is the responsibility of the founders and management of the small business.
And I have seen so often people,
businesses fail spectacularly because the the the founders who had grown up in large corporate world thought they could, you know,
bring their their skills of whatever goods and services they've they've they've
demonstrated they could deliver bring those to an entrepreneurial world.
They can do that.
What they can't do is bring themselves to concentrate on the small stuff, which will actually pull the rug out from under any small business.
And this is one example where it needs to be done.
Right. What's accounting then? What's the difference with that in bookkeeping? Now there is there's the accountant.
Okay. You can tell he's an accountant. Is there light?
He's got the coffee to keep him away because it's very, very light. Look at the shadows.
His time is off. I'm done. Because, you know, that's. That's our lives.
We work far harder than everybody else put together now. Okay.
What does he. What is. What is all this about? I can't see. Why is it so flaming, complicated and mysterious?
What? You know, surely, surely.
You just, you know, if you want to know the profit, you just get the money in and subtract the money out and hey, presto, that's what was what.
Why is it so weird? Okay. And what was this debit and credit nonsense?
What's that about then? Plus and minus is fine for, you know, every science and every you know what?
Why do we have to have new words for it? You know, this just accountants making make it work for themselves is obviously, you know is okay.
Well we'll have a look at that and see what we're we're talking about the profit loss account.
You've heard of one of those? What's it about? It's about revenue earned.
Okay. And I used the word earned and put they put the old emphasis on that rather than revenue received.
Because. Well, you see why in a second.
And you need to deduct from that the costs incurred, not the ones that were paid, the ones that were incurred.
There. What's the difference between them? Well. There's a sort of, you know, natural use of the words incurred and paid.
You can pay this year for something you incurred last year. You you might have bought something, a service or had some goods delivered last period.
And because you bought them on credit, you're allowed to pay for them this year.
But the year that they need to go in and be deducted from your revenue is the year you use them, which is last year, not the year you paid for them.
So it's quite important to get these things right. So you arrive at the profit and that's the profit for the period in question.
So it is actually meaningful to talk about the result, the profit or loss for a period and the profit loss account represents a period.
Okay. The other main report in a set of accounts is the balance sheet slightly more mysterious,
but actually all it is is taking all the assets, all the good things, which might be physical, good things like.
Like desks and chairs and computers and motorcars or sort of.
Clearly notable good things like money in the bank or money in the tin, or slightly less obvious things.
But the fact that somebody owes us money a debtor is an asset as well.
Or even more intangible, things like goodwill know how.
Intellectual property, but they're all pluses, they're all assets of the business and they all go on the balance sheet.
On the debit side, you take away all the liabilities.
They basically are things you owe obligations.
You have to do something or pay something, and they come off and you end up with the net worth of the business.
Now, that's the accounting net worth, by the way, not what the business should be sold for.
Don't confuse the two. But but it is it is an important number.
And that's the net worth at the balance sheet date. So the balance sheet is a snapshot.
At a particular date, you have a profit loss account for the period. And then then the balance sheet represents a snapshot at the end of that period.
It is meaningless to talk about the balance sheet for a period.
Okay. You will hear people talk about it. But actually the balance sheet is as at a particular date the profit loss account is for a period.
These are the main reports in a set of accounts, and they report how it performed and how it ended up at the end of the period.
So let's see if we can maybe dispel the myth of money.
Money in minus money out gives you the result.
Here is an example of very simple business, and in its first reporting period, it buys 100 widgets and it pays a pound each for them,
and therefore cash out is 100 quid and it sells those widgets for two and £2, 50 a pop, and therefore it gets in £250.
And the profit, the end of the month is £150. And that is also the increase in cash.
See, I told you so. I okay.
That simple business, it works. If all you do is cash in, cash out, you do cash purchases, cash sales, you have a drive.
On the other hand, let's just make it a tiny, tiny bit more complicated.
Buy 100 widgets at a pound. You see a pattern emerging here.
Sell those hundred widgets and this is a more profitable sale because they were not £2.50 but to 75.
But we sell them on credit because we've we've agreed 60 day terms with our supplier.
And we know you sound with our customer and we know this customer is sound they're going to pay, but they just want 60 days in which to do so.
So no cash is received during the period that we're reporting for because the 60 days finishes after the end of it.
You agree that on the cash basis, purely we've had a loss of £100, we've shelled out 100, received nothing.
But, you know, if you do it properly, clearly, that's that's a profit of 175 quid.
On what we call the accruals bases where you match the costs when they're incurred with the revenues when they are and.
Okay. So we've already, with this really, really simple example, demonstrated the proper result.
I think you agree the meaningful result is 175 plus the the result, if we just did money in, minus money out would give us a silly result.
And just one more to do that. We've got a thousand widgets now and we only sell 100 of them.
3.15 with the prices of these widgets is going up beautifully.
We like this, okay? And it sells 100 of them and we get 315 and on the cash basis we actually make a loss of 685,000 out 350.
Again, obviously nonsense because really the thing that matters is a 350 that sold and those 350 cost us 100 didn't they.
A thousand I hundred. They're all a pound a peach so a hundred of them cost us £100 and so we've made
a profit of 215 and we would have stock of 900 quid at the end of the month.
Okay. Sorry.
That's that's again, we haven't got very complicated now, really straightforward business,
but we've already got, you know, debtors, creditors, accruals stock and all these kind of things that that we.
Strange creatures called accountants like to talk about. And it really isn't a very, very difficult example when when the business has got many,
many product lines and many, many stock lines and does manufacturing and so on, it's not just buying and selling.
The whole thing gets even more complicated. And yes, you do need debits and credits and all this kind of nonsense to get it right.
Okay. The reason for debits and credits. Well, the answer is positive and negative.
Don't quite cut the mustard. I think you would agree that if you're if you were to say your bank balance is positive,
it means you've got some money in the bank, which is clearly an asset. Okay.
Similarly, if you said that the balance to the balance on my plastic supplier is a positive balance, I would expect I owe him something.
Okay. My plastic supplier has obviously sent me a bill and I owe him £100.
Those are both positive in any sort of natural sense of the word positive.
But there are opposite signs. One is an asset. And the other one is a liability.
So because positive or negative doesn't really do that, do the business.
We've got these words debit and credit that these two signs are opposite, even though they're both positive in any sort of natural sense.
So the first one, the asset is a debit. The second is a credit.
Sales and cost of sales are profit loss account items. A positive number in sales means we've earned some income.
A positive number in a cost like cost of sales or an overhead like rent would mean we've incurred some rent.
They're both positive, but they're opposite. Inside one is income and therefore a credit.
The other one is a cost and therefore a debit.
We need those words because they the positive are the old positive and negative.
Don't don't simply don't cut the mustard. Okay.
So what? What is it that accountants do? Why do you need an accountant?
You know, and the answer is to get from raw data to useful information.
Okay.
The guy who sells you, the salesman from the from the accounting software company will tell you that his software will prepare your accounts for you.
Okay. The I would say the analogy is with the guy from from the hardware store sells you a spade on the grounds that it will dig a hole for you.
Now a spade will not dig a hole for you. It's an awful lot easier to dig a hole with a spade than it is with your bare hands.
By the end of the day, it will not do it for you. And the same is true of accounting.
Software is a lot easier to prepare accounts from the raw data using accounting software.
It's a lot easier than just using a piece of paper and a pencil, but you still need to do it.
There's still a job to be done. What is that job? We're going from the books, the raw data capture to the accounts, which is useful information,
and even from absolutely perfect books that have been maintained properly.
There's still things that you need to do to them to get to the to get to the of information.
For example, we have lots of non-cash and non-paper transactions.
Stock movement. Okay. As stock is counted.
It doesn't. Miraculously, that information that comes out of the stock account doesn't miraculously get into the books and records.
Depreciation. Okay. What we're here talking about here is you buy an asset, you use it over five years and it wears out over five years.
It doesn't produce a doc. It's to say I've worn out buy £100 worth that you can record in the books.
You need to make adjustments for it using estimates and accounting adjustments, accruals and prepayments where you have incurred a cost.
The classic one is something like a telephone, quarterly telephone bill, you, you.
The beginning of the quarter, you start using your phone the next month of the quarter, you start using the phone,
you have an accounting year end and then in the final quarter, you get a bill for £30,000 for the quarter.
Well, let's be honest, that isn't nought nought 3000 of costs incurred.
It's probably about a thousand, a thousand, a thousand.
But unless you make some kind of adjustment for it, it'll look as if you incurred nothing in November, nothing in December, and £3,000 in January.
But you need to adjust for it. Similarly, prepayments the other way round.
You pay for a cost. You pay your insurance premium in advance.
Unless you make an adjustment for it, it'll look as though in January you spent £12,000 on insurance,
and then it's through February two, through to December, you didn't spend a penny.
Whereas in truth, the actual cost was about £1,000 a month, and you need to put adjustments through to get to that.
Okay. Who uses accounts? We've got lots of people who do.
And we're going to I'm going to look at the management type accounts,
which are clearly the title used designed with management in mind, designed to be useful to management as one sort.
And obviously, management use it to make decisions about how the business is going and what.
Steps they can take to take advantage of. Good news from those figures.
This product line is doing well. Let's spend more effort on it. Remedial steps.
This product lines doing rubbish will close it down or sort it out somehow.
The investors, the shareholders we talked about, these business angels have come along and pumped a lot of money into your business.
Good point. You know, they will want to know how things are going.
They want to know that you're spending their money properly and that your business performance is in line with what you promised them.
It would be lenders. The banks.
If you are the kind of business that can borrow money, then lend it to you.
But they'd like to monitor how you're doing with it just to to make sure.
And they want to see these accounts.
Anybody who might be looking to buy your business at the end when you're trying to sell it and make a lot of money out of it.
Basically, anybody you want to see these accounts can see these accounts, but only if you want to see them.
The owners of the business have these and can keep them secret.
Financial statements, on the other hand, are a more formal compulsory document.
External regulations. We want to see them. The taxman uses them to to work out the tax.
They've got to go to companies, house the shareholders.
Every shareholders entitled to a copy of the financial statements, the annual accounts.
Customers can go to Companies House to see them. Suppliers can go to the companies house and see them.
Competitors could go to companies house and say, Let me just get a bit scary, isn't it?
The good news is that you can keep disclosure to a minimum. Most small businesses can file what are called abbreviated accounts.
We don't give too much information away, okay?
But they still have to file accounts and they still have to prepare the full set.
Employees could go to Companies House and see what they what the fat cats who oppress them a taking out of the business.
Need to be aware of that kind of thing. Basically, anybody can go to Companies House for payment of a modest fee.
See what the accounts of every company look like.
So let's look at the management account side. Usually the accounts profit loss account, balance sheet.
Okay. What else do they have? Often comparison with budget.
That's a very good thing to do.
All comparison with last year to see how the business which what direction the business is trending in the often include variance analysis.
So if turnover is a lot higher. Is that because we put our prices up or because we sold more?
And good variance analysis would split the the increase between a volume increase in the price increase.
And you put key performance indicators in there. I like key performance indicators and they've got to be designed with the specific business in mind.
So let's have a look at some. They don't have to be financial.
I'm a I'm a financial person myself, but actually I'm a big fan of non-financial key performance indicators because they,
you know, they tend to be more comprehensible to the to the ordinary members of the organisation who want to know how we're doing.
So just a simple example.
You got recruitment agency that specialises in temps, the simple number of weekly, you know, each Friday, how many temps do we have out of clients?
That's a really, really good indicator of how the business is doing.
And if you set yourself targets to do that and and monitor your performance against that, that's a fabulous KPI.
In a distribution business, you might have stock turnover, so you're buying stuff and distributing it amongst,
you know, buying stuff and importing it maybe and distributing it amongst a number of customers.
Stock turnover day is the how long do you on average do you hang onto your stock before you sell it?
Because if that's too high, you're spending too much money on just holding stock that isn't doing anything for you.
You're wasting your capital.
If it's too low, you probably are at risk of not being able to provide your customers with what they need when they need it.
And so you need to get that in balance. Web Marketing Business.
You might have a number of hits to client sites as your.
As your key performance indicator. That's nice one,
because something like Google Analytics will actually collect that figure for you and you don't have to worry too much about doing it.
Just publish it in your your monthly reporting document so that everybody can see.
So. What this is all about.
You've got to involve management. They've got to understand the financial information.
They've got to have confidence in it. It's no good if they don't believe that is a true reflection of how the business is performing.
They've got to review it to make sure that it is in line with what they expect and so on,
and they've got to have meetings and discuss it even in the tiniest little business.
This is this is this is not something you can go, Oh, we don't need to bother about meeting,
you know, monthly meetings, quarterly meetings to discuss the accounts.
You do trust me. You do.
Because anybody who doesn't is taken off the board and they risk, you know, all sorts of disasters happening to the to the business.
So management information is pretty important. And unwillingness to to give it the attention it deserves is courting failure.
It is not someone else's problem in an SMB.
It is in a big corporate, which is why these people have such a challenge going from one culture to the other.
It is someone else's problem. There's a whole finance department to look after that would have to worry about it.
And that smee is everybody's problem. What else do we use management accounts for?
Well, as I say, reporting to the business angels or whatever lenders and so on,
potential providers of finance, frequency, monthly, quarterly, half yearly, whatever suitable.
And they have credibility. If you've got someone coming along, maybe a potential customer, maybe a supplier,
maybe a potential partner in some venture that you're going to maybe a possible acquirer or lender.
Any of those will go kind of see the management accounts. And if you go, I don't got any you just you lose credibility, okay?
If you if you're into those kind of those kind of dealings with people and want to be taken seriously,
you need to be able to say, yeah, we review these figures monthly.
Okay. There is there's cash and there's it's crown to show that it is king.
And okay, that is the hockey stick curve is typical of start up businesses.
They have they have no turnover. They spend money.
So the cash goes downhill and then they they start to build up sales and and so revenues start to cover some of those costs.
And eventually you'll get reached the bottom of the pit, the break even point where money coming in exceeds money going out.
And hopefully that as long as that improves, we start going up the hockey stick and eventually start generating cash.
Okay. Typical early stage, high growth companies.
Now there's that phrase depth of trough is sensitive to slippage.
What I mean by slippage is it just takes that little tiny bit longer to get the sales going,
to get the revenues up, or they don't quite build up as fast as you thought they were going to.
The how deep that trough is and when it happens is incredibly sensitive to that.
And, you know, anybody who's built a a decent set of projections of a start up business.
That has tried a bit of flexing and said, well, what happens if sales take three months longer to get going?
Or what happens if sales we only achieve 50% of all of our growth planned and so on?
And the one thing that happens really quite scarily is not only does that thing get wider, but it gets deeper and quite scarily deeper.
Okay. It really is very, very sensitive.
You know, an extra month before your sales start taking off,
you've got a whole month's worth of extra outgoings with no extra income to compensate for it,
and therefore it will be deeper by a whole month's cash burn.
So you need a plan B? Didn't want that plan B could be.
But you need a plan B. Could be having some back up funds.
It could be having. You know, some of your own savings.
It could be. Having warned your investors that actually you might need another funding round.
You need a plan B. So how do we how do we how do we sort of stop these disasters happening?
It is unforgivable to run out of cash and I think usually terminal for most businesses.
Most businesses don't fail for lack of sales. They fail for lack of cash.
So you need to monitor them. Need to plan and monitor them.
Calculate your cash burn. Okay, calculate. What if nothing comes in your spending each month or whatever?
And if you know how much money you've got in the bank, you know what your monthly cash burn is.
You only need to divide one by the other to find out what your life is.
Okay? You just divide the cash by the cash burn per month,
and that will tell you how many months you can survive before you need to have got those sales and revenues
coming in to compensate for it or another funding round or some other way of getting some cash in.
Let's move on to the formal financial reporting.
I've picked on a fairly large, well-known company there, Mark Sparks, with that's the front cover of that annual report.
And that's prepared for the shareholders.
The responsibility is to the shareholders, it's prepared by the directors and that is the responsibility of the directors.
And that's true of Marks and Spencer and you know, Oxford Widgets Ltd.
And even if they're audited, that's still the responsibility.
The directors, just the auditors are adding their name to the to the people that you can sue if they're wrong.
Directors are still to blame. So what's all this about the companies?
Act 26 is the current legislation that determines that companies have to prepare accounts and the
framework under which they have to prepare the accounts and they have to give a true and fair view.
Hang on a sec. A true and forgive you. Surely they have to give the true and fair view.
You know, anything else is going to be wrong, isn't it? Well, I'm afraid not, because there are different ways of representing certain things.
For example, it is possible.
When you spend money on research and development to say that's the cost of the year in which I do the research and development expense remittance,
the profit loss account, or it's possible to say no,
I've created an asset with that and I will capitalise it and put it in my balance sheet and provided the circumstances right.
You can choose. And both of them give a true and fair view their different true and fair view, and you need to disclose which one you've adopted.
So anybody who's reading the financial statements will understand which true in five you've given and how you arrived at it.
So you accounting standards and and there are notes and disclosures so that anybody reading the financial
statements knows the basis on which they're prepared and can work out the true and fair views that they've given.
What's an audit or an audit? Is someone else coming in and having a look and putting that putting their signature?
To a statement that says in a lot of words, but in broad terms, what it says is, I'm really, really certain that these are roughly right.
Okay. An audit will not go down and find to the last six months.
That's not what it's designed to do.
What is designed to do is it uses statistical sampling and all sorts of advanced sort of mathematical techniques to be really,
really certain that any any mistake isn't that big, because, after all, that's much more useful.
If you had if you had to find out that there are no mistakes whatsoever, the only way to do that is just do it all over again,
which is just out of, out of out of all proportion to the costs will be out of all proportion to the usefulness of such an exercise.
But if somebody can say now, I'm really, really certain that that nothing too bad.
Kind of could have slipped through these these accounts by mistake or deliberately.
That is actually quite a useful thing to have sometimes provided there is somebody looking at it who will get some comfort from that.
There is some debate. Many, many, many small companies are exempt from audit and quite honestly, the values that they add.
Is not that great. We tend to do audits for small companies where it's optional if, for example, the owners of the company are in another country.
So the management are running it and the owners want somebody to come and put an
independent view that the that what the management are telling them is actually true.
For example. So the debate about whether there's any added value.
So the financial statements, along with Dubai's saying the accounts, the annual accounts, they determine the corporation tax.
They go with a a corporation corporation tax return to HMRC.
Corporation tax return was a piece of paper for most of my professional life, and then it became a PDF of that.
Now none of that is good enough. No paper corporation tax returns, no PDF Corporation Tax Returns.
Corporation Tax Returns are now submitted in i XBRL.
In line extended business reporting language and that is a machine readable format which allows the the the
machines to check whether you're whether it looks as if you're on the fiddle in your corporation tax return.
You've got to file the accounts companies house.
But as I mentioned, abbreviated accounts for small companies and that gets gets you out of too much disclosure.
But that doesn't mean you don't have to do the full accounts. They're still needed for the shareholders and for H.M. Revenue and Customs.
You can't get out of full accounts for any company only, you know, only get out of filing full accounts by finding abbreviated ones.
They're just very quickly look at how entrepreneurs can get rewarded.
They can get salary or dividend out of that company,
or they can get money on an exit when they sell the business to Microsoft or AstraZeneca or whoever.
And we have a quick look at reward for key employees as well.
So dividends, dividends, you've probably heard very tax efficient Fernanda managed business and good things, but they can only be paid out of profits.
So the the pre-revenue company ain't going to be paying dividends for a while.
They must be paid to all the shareholders, not just the people who are working day to day in the business.
They must be paid to the shareholders in their shareholding ratio and it really does suit a profitable owner managed business, you know.
Fred and Susie set up a business, the 5050 shareholders. It makes a lot of money.
They pay each month. They have a dividend. Each year they have a dividend of half the the available profit.
Salaries, on the other hand, can be paid and nothing like as tax efficient, they can be paid out of pre-revenue companies,
but they there's loads of an AI and horrible costs on top of that, but they can be paid without regard to the shareholders.
So you can pay, obviously, somebody who has a relatively modest shareholding, a fair salary to attract them.
I'm just gonna bang on a bit about directors.
Anybody who tells you, Oh, I'm a non exec or I'm a, I'm a self-employed director and, and therefore I don't need to,
you know, the money that the company pays me can go, doesn't need to go through the P.A. system.
I'm sorry they are talking utter so I'm family show so I can't you but it's not true.
Directors are office holders. They are everything that they do for the company is subject to pay.
Okay. Don't let anybody tell you otherwise.
You will all you will always find somebody down the pub who says, Oh, well, my company pays me on a self-employed basis and that's alright.
It's only alright because H.M. Revenue Customs haven't looked at it yet.
It's not all right, it's illegal.
You know, and the trouble is that when they find out, they'll they'll they'll clobber you and find you and penalise you and do horrible things to you.
If the director operates through their own limited company, then they can be paid without operating pay.
But you've just shifted the problem. Anybody heard of a thing called I-35,
which which actually just moves the problem one down the line and makes the director's own little company have to pay pay on it.
It doesn't get you out of the problem. So this is employment status when you're engaging someone who claims to be self-employed.
You actually need to look at the relationship that self-employed is something which applies to relationships, not individuals.
Okay.
If it's too much like employment, the HMRC will ask for tax on the basis of the fees with a net pay that they operated, pay on the gross them up,
charge, tax and national insurance on the grossed up amount and they can go back six years and charge you interest and penalties as well.
Businesses have been have been bankrupted by people not dealing with people who
are really employees and charging them tax through the pay system accordingly.
Awful warning payroll full of bear traps, full of pitfalls.
In the rare occasions when it's simple, you don't worry about it.
But it really is a scary place for the unwary.
All the acronyms are real time submission, safety, sick pay, statutory presented by statutory paternity pay, student loan deductions, pensions.
And now with auto enrolment, you know, and this dates when every company of college A has to be auto enrolled into the pension regime.
Directors and I which is weirdly different from ordinary human beings.
And I don't try just to outsource that to specialists.
It's it's a it's a commodity. And people will do that right for you.
You don't need to worry about it. I will quickly talk about benefits in kind.
Just to say don't bother because they're very rarely tax efficient.
HMRC have set up rules that if you start giving people benefits in the way of sort of remuneration them under the under the radar,
it won't be under the radar and you'll get into trouble. Used to be good for cars.
No, no. Nobody now operates a company car.
Unless you're a salesman doing 18,000 miles a year or something like that.
Sometimes you have to do it. I mean, you can't get a salesman unless you give them a car.
But don't expect it to be tax efficient. Beneficial loans.
They used to be really great back in the days when interest rates were high.
But actually now, you know, interest rate, if if if you're able to borrow the money, you might as well pay the full interest rate.
And it's not a problem. Accommodation works if if you're the janitor in a school, that's about it, you know?
You know,
you can't you can't give people a company flat without them paying the amount of tax that they would have paid if they'd paid for their own flat.
It just doesn't work. Okay. The only one remaining tax efficient benefit in is pension, because you can pay that within the limits, the legal limits.
You can you can attract people by paying pension on their behalf. And there will not be a tax liability on it.
Let's quick talk talk quickly about employee participation.
Employees, you know, you want you've got somebody who you really like to come work for you and.
You can sort of afford them, but actually you'd really like to sort of bring them in,
nailed them in place, get them committed to your your new business.
How do we do that? So the question I'm asking is a good idea to encourage employees with share ownership.
Two risks that I and this is awful warning.
First one, it can be difficult to undo. You can sack somebody as an employee.
You might have to pay them pay them compensation.
But at the end of the day, you can get rid of them. You can sack somebody as a director again.
You might have to pay them compensation, but you can get rid of them. You cannot sack somebody as a shareholder.
If they've got a share certificate, they can hang on to it.
Unless you have unless they're prepared to let it go or you've got a shareholder agreement with clauses in that allow you to to to claw them back.
So that's the first risk.
And the other one is that tax liabilities, as we saw earlier, for people coming in to shareholdings and valuable companies, can be very scary.
On the other hand, as a staff retention strategy is quite a good idea because people feel more involved.
They feel valued if they've got shares. So how do we do that?
Well, let's look at it. Three reasons for owning shares. What shares?
Give you three things. They allow you to vote. They allow you to share in any dividend that gets paid.
And they allow you to share in the proceeds of an exit. The company sold to Microsoft or AstraZeneca and with a for a big check.
And if you've got 5% of the shares, you get 5% of the check.
Let's be honest, in an SME a one is irrelevant the voting because the founders alone sort of 80% of the company
and you're 5% amongst you know you're not going to be able to vote in any meaningful way.
Number two can be replaced with a bonus scheme. If you really want to incentivise people and give them money as a share of the profit,
you can give, give them a bonus, which is a share of the profit.
Not quite as tax efficient as dividend, but let's be honest, you know, that's that's a minor price to pay for getting it right.
It's three that really matters. What you want them to do is you want them to help you build up the value of the business
so that that cheque that Microsoft or AstraZeneca can come along with is enormous cheque.
And therefore,
you don't mind if they get an enormous part of an enormous cheque because your enormous part is going to be even more enormous than theirs.
So we want to encourage them with that, and that's the thing that matters.
So how do we bring about the situation where these people can share in that enormity of that cheque?
And the answer is of the downside of doing it is that if you issue the shares to the employees anything less than full market value,
then they've got to pay tax on the discount that you've allowed them.
That's what we saw earlier. So we're trying to get this employee participation in the growth without them having a huge tax bill.
And how do we do that? And the answer is, I think my enterprise management incentive, which is a government scheme, is a tax scheme.
So what I mean about sometimes the taxman can actually be quite nice or the treasury can be quite nice and bring in rules that allow you to do it.
You can essentially grant people options, the set of rules under which it happens and they don't have to pay any tax when their options are granted.
They don't have to pay any tax.
When the options are exercised, you grant them of the current market value, but they don't actually have to exercise them until,
you know, five years time when the value of the company shot through the roof.
But they still don't have any tax to pay until they actually sell the shares, usually on an exit when,
as I say, one of the one of the big boys comes along with that enormous cheque.
And they exercise them and there's no tax when they're granted.
There's no tax on the exercise, and they only have to pay capital gains tax on the uplift.
And thanks to a fairly recent change in the law that happened last year,
they only have to pay 10% tax on that uplift because of a thing called entrepreneur's relief, which now applies to EMI shares.
So what I'm trying to say here is that if you don't think about these things and take advice and make sure you comply with the rules,
you have these horror stories that I showed you at the beginning, if you'll if you check on the rules.
There are ways to do these things properly. But you need to you need to make sure you're properly advised on how these things work.
Okay. Doesn't mean. I'm sorry. I'm. I'm over running, but I haven't been kicked out yet, so I'll keep going until I am on an exit.
How's business valued? There is no single, meaningful way. There's no formula.
And in a typical investment company, which has got lots of properties.
Then you just value the properties and have them together. That's easy.
But most of them, it's what they call the present value of the future earnings,
the earnings stream back in that you can't you estimate what the company is
going to make and then you calculate what the capital equivalent of that is,
and that is the value of the company. But there's a lot of unknowns, a lot of parameters that you feed into there that are sort of.
You know, I think it will make this much money.
I think an appropriate price, earnings multiple is this. I think that the costs incurred I will incur to achieve that will be these.
But you just don't know. The real value is determined by horse trading.
What will someone pay for it? That is the real value of the company.
And it's the same. You know, the surveyor comes along and tells you your house is worth 487,002 and £21.60.
Helpful. But actually, unless somebody is prepared to pay that, it's it's so much nonsense.
And the same is true of company valuations needs to be worth that to somebody.
Due diligence. Yes. You've got your business going.
You've got up and running. You've made a load of money. And the the the, you know, key industry player is sniffing around, wanting to buy you out.
And they want to come in and check that everything is as you say it is.
So they will do due diligence and and they will look closely.
They will kick the tires. Examined in detail by a prospective purchaser.
And they will look at your financial controls and your financial disciplines, among other things.
They look at your technology, they look at your staff, they look at your h.r procedures.
They look at your contracts.
But the bits that we have to worry about in today's session is the financial controls and disciplines and they will be scrutinised in some detail.
You will be fine. Does she have great controls?
Because you've been here today. Thank you very much.